Germany - The Strategic View - Aviation 2017

Dr. Wiebke Seyffert and Jana-Natascha Garish discuss the controversies surrounding international airport development in Germany, the subsequent decline of regional airports and the need for new aviation technology regulations

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1. Currently, what are the main issues (strategic and political) affecting those in the aviation sector in your jurisdiction?

Strategic wise, the German aviation market has been continuously subject to severe changes since flying to national and international destinations was opened to EU-wide competition.  This led to a tremendous increase of low cost carriers and a respective increase of passenger volumes in Germany.  Further, we have an increase of high-end carriers, mainly from the Middle East, that address the special requirements of passengers demanding luxury equipment and first class service.  For German national airlines, this poses increasing competition from foreign airlines requiring adequate responses to these developments.  So far these airlines try to develop in both directions – i.e. the low cost and the premium sector.  However, given certain standards German airlines used to grant to their customers and also to their employees, this is a very difficult process and it remains to be seen if their strategy is successful.

We have many political issues that affect aviation in Germany: there are a number of tax issues such as a possible tax on kerosene – a permanent issue on the political agenda – as well as the taxation on air transport that was introduced in 2011 and that is very controversially discussed.  Another subject is the allocation of airport slots.  A very prominent example is the discussion that Air Berlin entered into with the Federal Aviation Office on its codeshare flights with Ethiad.  Further political implication has been the opening of the new airport in Berlin – an airport project that was struck by huge technical as well as political obstacles.  The actual opening date is still not foreseeable.  German airports always give rise for political discussion: while large airports have to cope with rising passenger volumes and therefore an increase in aircraft movements, which causes discussions on curfews and the building of new runways and terminals, some small local airports are struggling as they have been highly subsidised by local governments but the demand for flights to regional airports is much lower than expected. 

2. Where has your jurisdiction seen the most growth in the aviation sector over the past 12–18 months? And, if any, where do you anticipate growth coming from during the next 12 months?

A new record in the low-cost sector was achieved at the beginning of 2015.  Official figures suggest about 217 million passengers have been handled in 2015 at 26 international and regional German airports.  Thereof, 68.5 million passengers were transported by low-cost carriers – with an upwards trend to be expected in 2016.  The German airlines try to participate as much as possible in the growing market but they are facing tremendous pressure.  Lufthansa, as the national carrier, reacted by a large restructuring process and by establishing low-cost carriers as subsidiaries.  The newly-founded Eurowings is expected to also serve long haul destinations as a low cost carrier.  The other large German carrier, Air Berlin, is also trying to serve low fare as well as premium passengers at the same time.  To serve the latter, and to extend the number of destinations, Air Berlin reached out to investors in the Middle East.  Overall, it appears that a diametrical development of network expansion and frequency extension can be observed: while the number of flights and the number of seats is increasing, the number of routes has declined.  This does of course have an impact on the structure of the fleet, requiring respective planning with regard to the number and size of aircrafts.  The pressure from other airlines will continue and might lead to some more profound actions by the German carriers.  The idea of takeovers is mentioned in regular intervals; so far, only as rumor.

3. Does the GDS distribution model continue unchallenged as the most popular model for flight distribution?

Tickets are increasingly sold through vendors’ own direct-distribution channels and partner systems in order to reduce the dependency on GDS systems and to cross-sell to partner airlines and via travel agents.  Also, many price comparison websites make it easier for customers and travel agents to compare point-in-time prices and availability of flights.  Lufthansa Group and several other major airlines have already announced that they would impose an additional charge when bookings are made through an external GDS rather than through their own systems, as the costs of using external systems would be higher than their own.  Although it has been anticipated that GDS systems will vanish by 2020, in our view, these systems will still be in use but they cannot be regarded as unchallenged.  However, the four most common computer reservation systems (Amadeus, Galileo (Travelport), Sabre, and Worldspan (Travelport)) can still be described as the most popular models.

4. In your jurisdiction, does airport capacity require boosting and, if so (and even if not), what plans and/or processes are in place to address this (or increase or re-organise airport capacity, as the case may be)?

Statistics say that German airports counted around 103 million passengers in the first half of 2016 (an increase of 3 % to the same period in 2015).  The number of travellers to and from Germany has been growing steadily for years, and has led to a demand for more airport capacity.

Germany’s economic need to boost airport capacities is increasingly under scrutiny by politicians and the public and has become a very controversial issue.  Any decisions leading to higher capacities, such as the building of new runways or terminals, or the reduction of curfew hours, are highly unpopular with the local public or environmental organisations.  However, in order to remain competitive in the international market, there is an urgent need for night flight options and the expansion of airports.

The constant growth mainly refers to large airports while the smaller regional ones are experiencing a strong decline of passenger capacities.  Hardly any of the numerous smaller airports in Germany are permanently generating substantial profits.  The initial losses have to be absorbed by the local governments and municipalities who are dealing with strained public budgets anyway.  Some airports try to attract new investors but often to no avail.  Initially, low fare carriers had been attracted by very favorable terms.  This led to a continuing loss of profit, but still the local governments kept subsidising these airports. Furthermore, since low-fare carriers are increasingly focusing more on large airports, it is difficult to maintain regular services at the local airports, and we have already seen the first insolvencies.  If no new investors are found and no new ways to attract airlines to the local regions are developed, we will probably see more airports closing down in the near future.

5. Does the national "flag" carrier carry the most passengers into and out of the national airports and: (a) if so, what competition exists and how significant is it?; and (b) if not, what are your thoughts on the reasons for this, and why do competing airlines have higher load factors?

Lufthansa Group is one of Europe's major airlines.  In July 2016, official figures show that the Group transported more than 11 million passengers (+ 2% compared with the previous year).  Approximately 6.2 million passengers chose Lufthansa.  The low-cost carrier Eurowings saw an increase of the number of passengers in July 2016 of around 12% to 1.9 million.  Also, other members of the Lufthansa Group reported an increase in the number of passengers.  However, Lufthansa’s position is challenged by other airlines.  Lufthansa’s answer to this development is the establishment of new airlines such as Germanwings, and lately Eurowings.  Germanwings is about to be gradually converted into Eurowings.  With this move, Lufthansa has strongly expanded the flight frequency in the low-cost segment.  Even long-haul destinations are now to be found in the flight plan.  Reorganising the structures is Lufthansa’s reaction to the strong competition from premium airlines from the Middle East, as well as from major European low-fare carriers.  Due to its well-established reputation in the market, the name Lufthansa will remain the most important brand within the Group.  With the new brand Eurowings, the airline will be more flexible to meet passenger’s demands, i.e. a low-cost flight or a premium flight with as much service as possible.  To keep up this “two-tier system” will be one of the biggest future challenges for the German carrier.

6. What trends, in terms of regulatory intervention and involvement, has your jurisdiction observed over the past 12–18 months in relation to airline acquisitions and alliances?  Do you anticipate a change in the regulatory environment of your jurisdiction during the coming 12 months, and if so, how?

Regulatory intervention would take place on a European anti-trust level rather than on a national German level.  However, there are some market-related facts that will certainly influence airline acquisitions.  The most significant change is the rise of low-fare carriers, which increasingly offer domestic flights in Germany.  Such carriers no longer restrict themselves to the tourists and small local airports; but rather aim to cater for business travellers and offer connections between major cities.  While the market share of these airlines already amounts to 50% in some countries such as the UK, in Germany, it is officially quoted to be 25%; however, the share is expected to grow significantly in the years to come.  This has forced established airlines to adjust their services by creating their own low-cost offers.  From a regulatory point of view, it is up to the Federal Aviation Office to monitor the frequency of flights and the number of destinations.  A prominent recent action was the restrictions on the 2015 winter flight plan filed by Air Berlin and its shareholder Ethiad.  For the time being, a solution was found but further interventions by the aviation authorities could be possible.

7. What trends are being observed in relation to new technologies – such as UAVs/drones – and what impact are these technologies having on the aviation regulatory environment?

Drones will be the aircrafts of the future.  This does not only apply for military but also for commercial and private use.  In the long run, we might even see aircrafts without pilots.  New technology is developed with respect to different modes of individual transport, such as fully automatic air taxis, etc.  It can be expected that the technical means will be available in less than 20 years.

The German Ministry of Transportation and Digital Infrastructure (BMVI) is currently working on changes to the existing drone regulation regime.  The German Air Traffic Act defines unmanned aerial systems (UAS) as unmanned aerial vehicles (UAV) that are not used for private purposes.  The operation of a UAV that weighs more than 5 kilograms requires authorisation from the local aviation authority.  Permits will be granted if the operation of the UAV does not present a risk to air safety or public safety or public order, and if rules on data protection and privacy are observed.  Operating a UAV that weighs above 25 kilograms or operating it outside of the visual line of sight is generally prohibited.  According to the BMVI proposal, all UAVs weighing more than 0.5 kilograms would have to be registered in order to be able to hold the operator/owner accountable if it is used in an unsafe manner or for illegal purposes.  The proposal would explore possibilities for the use of UAVs for agriculture use and for traffic control (commercial use).  State aviation authorities would be authorised to allow the operation of UAVs outside of the operator’s visual line of sight if safe operation can be ensured.  Currently, operation outside of the line of sight is prohibited.  Additionally, a pilot certificate granted by the Federal Aviation Office for commercial UAV users will be required.  The proposal would strictly prohibit UAV flights for private use that are:

  • more than 100 metres above ground;
  • outside of the visual line of sight of the operator;
  • above industrial complexes, correctional facilities, military complexes, power plants, power generation and distribution facilities, or federal highways and railroads; and
  • at the operation site of police or other security agencies or organisations.


We still expect some discussions before the proposal becomes final legislation.

8. Legal issues in the “lease-to-part out” market.  A major market development is the interest of investors purchasing mid–end life aircraft on lease for the purposes of making returns on a leasetail and component margin model.  What challenges are inherent in this segment of the aviation finance market, and what techniques and disciplines are required to manage the risks involved?

The economic rationale behind lease-to-part-out transactions is that during the life of an aircraft, its value depreciates due to the increased cost of maintenance, repair and upgrading required to comply with legislation.  At some point in time, the value of the single components might exceed the value of the overall aircraft.

Generally, there are various possible financing structures of an aircraft.  It may have been purchased by the existing owner on the basis of a bilateral or syndicated (mortgage) bank loan or be the subject of a finance lease, a sale and lease back arrangement, securitisation, an ECA financing, financing via bonds or Islamic Finance structures.

The part-out investor has to ensure that it obtains title to the aircraft free of encumbrances and rights of repossession by the counterparty.  The way the aircraft is taken over out of the existing structure depends on the type of such structure and on tax considerations.  Where the aircraft is subject to a mortgage loan, stepping into the existing structure would entail difficulties under German law.  The change of the borrower would typically cause issues for the lenders, and the dismantling of an aircraft subject to mortgage would give rise to questions of title.  Where the aircraft is leased, the part-out investor would typically take over the lease from the original lessee.

When taking over the existing arrangements, further changes to the current documentation in addition to the transfer of contract might become necessary.  This affects in particular the covenants regarding the use of the aircraft, the counterparty's rights to terminate the agreement and to repossess the aircraft, and the arrangements regarding the redelivery of the aircraft on expiry of the term of the contract.

Further, the transaction might involve the laws of multiple jurisdictions and questions of conflicts of laws, as the financing documentation (loan agreement, lease agreement, etc.), the security documentation (mortgage, security assignments) and questions of ownership are not necessarily governed by the same law.

The second hand market is tightly regulated, and the re-insertion of parts into service must be strictly documented.

For the rest, key considerations for the part-out investor are of commercial rather than of legal nature.  The part-out investor has to forecast demand in the spares market and ensure that it does not over-pay for the asset.  Also, where the investor does arrange for the dismantling of the aircraft personally, it must ensure that a tear down facility by a licensed operator is available.  Further, in order to cover mismatching payments between the lease rentals and the revenues generated by the sale of the spare parts, a backup credit facility might be necessary.

9. Manufacturer support in the new cycle of new OEM products, e.g. MRJ, E2, C-series, etc.  In an increasingly sophisticated and competitive environment, in what way is the type of OEM financial and product support for this new era of aircraft more complex and far-reaching than in previous cycles?

As airlines operate in a very competitive environment, they are closely looking at potential saving possibilities.  With respect to OEM parts, more contenders and suppliers have entered the market offering a bigger variety of components, OEM and non OEM products.  However, airlines have to decide if they should reduce costs by using the latter components.  As many airlines run their own tests on samples of OEM parts and non-OEM products, these tests have become as complex as the range of products that are offered.  They include more sophisticated administrative tests, as well as technical reviews to provide for the airworthiness of the product; an aspect that severely affects the potential savings.

10. The advent of cheaper oil and the knock-on effects.  What are the consequences that arise as a result of the unexpected purchasing power of a number of third/fourth-tier airlines? What will challenge lessors and suppliers in particular as they are faced with speculative judgments on an airline's longer-term financial viability?

So far, cheaper oil did not lead to a larger number of newly established small airlines.  Currently, official figures suggest that 137 German airlines hold a licence granted by the Federal Aviation Office.  In effect, the number declined over the years after having reached a peak in 2010 with 170 licences.  Currently, it might be economically attractive to make a short-term profit with an airline; however, legal rules on establishing an airline in Germany are very strict.  The Federal Aviation Office is strictly monitoring the founding process and the operation of the airline itself; this includes the examination of the economic viability, the technical requirements of the aircrafts, as well as closely monitoring the maintenance of the aircraft.  Furthermore, staff have to be trained according to specific rules and the airline has to meet quality management standards, as well as many safety rules.  If all these requirements are met, it might be a big bonus for a new airline if the cost bloc for oil can be kept low, but since there are many other aspects that have to be observed, Germany does not seem to experience a boom of the establishment of new airlines.

11. Iran and the market return.  What remain as barriers, including sanctions-related issues to navigate, where Iran and aerospace and aircraft transactions are concerned?  What sort of jurisdiction is Iran from a risk perspective, and what techniques from a supply perspective are likely to be needed so that Iran's potential and promise for OEMs, lessors, suppliers and service providers is realised and does not become the latest example of a disappointing gold rush?

The Iranian air transport industry is currently undergoing radical change.  To modernise its outdated fleet, Iran is about to conclude promising bulk orders.

Despite the nuclear agreement between Iran and the West in July 2015, and the lifting of economic sanctions in January 2016, there are major issues concerning Iranian transactions.  So far, the Iranian bulk order of many Airbus aircrafts could not be signed because of unsolved financing.  European and German banks with US related business are very reluctant to enter into finance agreements as they fear that the US might regard these transactions as infringement of US sanctions still in force. In the past German banks were forced to pay huge amounts of fines as they financed projects in Iran which were – in view of the US – illegal under US law. Currently there is no clear stand by the US as to what would qualify as legal transaction. As this is a rather political question no solution is to be expected before the US presidential elections. Against the background of the gradual economic opening of Iran, German carriers will increase their cooperation with Iranian airlines in future.  This does include the assistance of the Iranian partner in the restructuring of companies and the IT sector.  Also, new destinations are planned as Iranian airlines will gain access to European airports and the Iranian capital Tehran is to be established as a hub.  The aim is clearly to establish competition with the carriers from the Middle East.

Considering the asymmetric lifting of sanctions by the EU and the US, it is important for companies from the EU to establish a well-considered market entry strategy as breaches against sanctions that are still in force might result in high penalties.

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Published 10/02/2017
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